The Benefits of Venture Capital Investing

A shareholders' survey by ENSIS indicated that the primary purchase motivators are receiving a tax credit, the recommendation of a financial advisor, and the knowledge that a portion of each individual's invested capital is supporting the growth of Manitoba based companies.

It is not uncommon for venture capital fund to respond to the inquiry of why the Federal and Provincial governments provide you, the investor, with a 30% tax credit. There are many reasons for the tax credit, the most significant of which is to attract patient investment capital to the private equity investment market. The Federal and provincial governments recognize that a robust supply of venture capital in a province creates sustainable jobs by supporting the growth of small and medium size businesses.

Beyond these obvious benefits to investing in a venture capital fund are the more compelling reasons for the tax credits, and more importantly, for the legislation that governs Labour Sponsored Investment Funds (LSIF's) within Manitoba.

When businesses have a supply of growth capital they are able to expand more rapidly creating new and better jobs and more stable and significant profit levels. Industry studies have shown that the incremental revenue to governments in the form of increased personal and corporate taxes very quickly pays for the cost of the tax credits. This is because when smaller firms that receive venture capital do succeed, they typically experience growth rates that are exponentially higher than that of established companies.

To maximize on this phenomenon, effective LSIFs must follow a disciplined approach to investing in and managing their portfolios. They must actively source and make deals, mentor and grow their portfolio companies, and ultimately exit them.

In order to ensure that funds perform in accordance with this venture capital framework, the Provincial government recently introduced investment pacing requirements for LSIFS. In a nutshell, the pacing requirements are as follows:

LSIFS must be 60% invested in eligible Manitoba businesses by the end of the year after the year that the funds were raised; over and above this, new monies coming in must be 60% invested in new companies (this means that funds cannot continue to only invest in companies that are already in their portfolios) by the end of the second year after the year that the funds were raised. Over the long term, this new pacing legislation is designed to prevent the funding of redemptions with new money - redemptions need to be funded from exits. For example, if a fund has $20 million in sales and $20 million in redemptions, it cannot just fund redemptions from monies raised by selling new shares. Redemptions must be funded by selling an investment from the portfolio, and new monies coming in must be invested in new companies. When these pacing requirements are met, the LSIF model truly benefits the local economy and shareholders, and the two levels or government maximize their tax revenues.

As part of the new Provincial pacing requirements, the province has now implemented a tax for LSIFs that do not comply with the new regulations. This charge would come directly out of the net asset value (NAV) of the fund, so it would have a direct effect on shareholders in that their shares would lose value.

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